1. Fuel Hedging A brownbag session at University of Montana September 15, 2006

2. My background Midway Airlines (Chicago, IL): 1989 - 1991 –Sr. Marketing Analyst –Staff Assistant to Sr. VP of Material Services –Manager of Jet Fuel Purchasing –Director of Jet Fuel Purchasing Jacobus Petroleum Products (Milwaukee, WI): 1992 – 1994 –Supply & Price Risk Manager Since 1996, I have primarily conducted research in corporate hedging –Recent publication: “Hedging and Firm Value: Evidence from the US Airline Industry” in Financial Management

3. Introduction to Jet Fuel Hedging Standard fuel purchasing practice –Hub airport: might own supply of fuel –Spoke airports: buy direct to plane –“Spot” prices on date of purchase Hedging strategies –Store fuel –Forward contracts –Swap contracts –Option contracts –Exchange-traded products vs. over-the-counter

4. Why would airlines hedge? Some common-sense reasons –Advance purchase fares…meet analyst EPS expectations –Ability to better set expense budgets Match to risk management theory –Underinvestment costs theory…extra cash flow provided when airline might need it to pursue optimal investment

5. Hedging and Firm Value: the Airline Evidence Carter, Simkins, and Rogers (2006) find evidence of a 5 – 10 percent hedging premium during 1992 – 2003. Hedging by airlines is best explained by underinvestment story. Premium is related to hedging’s interaction with capital investment.

6. Lessons learned Hedging will work best when “not necessary” – low volatility and low prices When hedging seems necessary, probably too late. Decent credit quality is necessary to hedge. Most businesspeople do not understand the objective of hedging.